Insurance contract law and its unique characteristics

A policy is a contract first

Every insurance policy is a legally enforceable contract between the policyowner and the insurer. That sounds obvious, but it matters on the exam and in practice: the rules that decide whether a claim is paid, whether an insurer can void a policy, and what a producer's statements bind the company to are contract-law rules. This lesson covers the four elements every contract needs, the extra element insurance adds, and the characteristics that make an insurance contract different from an ordinary one.

The four elements of any contract

Offer and acceptance (agreement). One party makes an offer and the other accepts it without changing its terms. In life insurance the applicant usually makes the offer by submitting the application with the first premium; the insurer accepts by issuing the policy as applied for. If the applicant sends the application without premium, the insurer makes the offer by issuing the policy and the applicant accepts by paying. A policy issued with a rating, a lower face amount, or an exclusion is a counteroffer that the applicant must accept before there is a contract.

Consideration. Each side must give something of value. The policyowner's consideration is the premium and the statements made in the application; the insurer's consideration is its promise to pay covered claims.

Competent parties. Both parties must have legal capacity. The insurer must be authorized to transact insurance; the applicant must be of legal age, of sound mind, and not under the influence of alcohol or drugs at the time of contracting.

Legal purpose. The contract must be for a lawful object and not against public policy. An insurance contract exists to transfer risk, not to create a wager on another person's life -- which is where insurance adds a fifth element.

Insurable interest -- the element insurance adds

A person may insure their own life for the benefit of anyone. But no one may procure insurance on another person's life unless the benefits are payable to the insured or the insured's personal representatives, or to someone who had an insurable interest in the insured at the time the contract was made (Fla. Stat. 627.404). Florida defines that interest for life, health, and disability insurance as one of the following: a person's interest in their own life, body, and health; a close relationship by blood or by law combined with a substantial interest engendered by love and affection; an expectation of substantial pecuniary advantage from the other person's continued life and substantial pecuniary loss from their death, injury, or disability; a party to a contract to buy or sell an interest in a business entity, as to each other party to that contract; and a trust or trustee, as to the grantor, the grantor's close relatives, or others in whom the grantor has an insurable interest (Fla. Stat. 627.404). The interest need only exist at inception -- it does not have to continue after coverage begins (Fla. Stat. 627.404). A divorced spouse or a former business partner who owns a policy on the other therefore keeps a valid contract.

What makes an insurance contract different

Contract of adhesion. The insurer writes the policy and the applicant either takes it or leaves it; there is no negotiation of terms. Because of that imbalance, courts resolve any genuine ambiguity in the language against the insurer and in favor of the insured.

Aleatory. The value exchanged is unequal and depends on chance. An insured may pay one premium and collect a large death benefit, or pay premiums for decades and never collect.

Unilateral. Only the insurer makes a legally enforceable promise. The policyowner is not obligated to keep paying premiums, but if the premium is paid, the insurer must perform.

Conditional. The insurer's obligation depends on conditions being met -- the premium paid, proof of loss furnished, the insured's death actually occurring within the terms of the policy.

Personal. The contract is between the insurer and a specific policyowner, based on that person's characteristics. A life policy can be assigned by the owner, but a property policy generally cannot be transferred to a new owner without the insurer's consent.

Utmost good faith. Both parties rely on the honesty of the other. The insurer relies on the applicant's answers because it cannot verify everything; the applicant relies on the insurer's promise. This is why misstatements in the application matter so much:

• A representation is a statement believed to be true to the best of the applicant's

knowledge. A material misrepresentation -- one that would have changed the insurer's decision to issue or to rate the policy -- can allow the insurer to void the contract.

• A warranty is a statement guaranteed to be true; a breach of warranty, material or

not, traditionally lets the insurer void the policy. Modern life and health policies treat the applicant's statements as representations, not warranties, in the absence of fraud.

• Concealment is the intentional withholding of a material fact. Fraud is a

deliberate misrepresentation made to deceive and induce the insurer to act.

Indemnity versus a valued contract. Property and casualty insurance is a contract of indemnity: it restores the insured to their pre-loss position and no better. Life insurance is a valued contract: it pays a stated face amount, because a human life has no market value to indemnify.

The entire contract and the application

The policy, together with the attached application and any riders and endorsements, is the entire contract. The application counts only if it actually travels with the policy: in Florida an application for a life or health policy or annuity is not admissible in evidence in an action on the policy unless a true copy was attached to or otherwise made part of the policy when issued (Fla. Stat. 627.408). After a reinstatement or renewal, the insured -- or a beneficiary or assignee of a life or health policy -- may request a copy of the original application in writing, and the insurer must deliver or mail a legible copy within 30 days (Fla. Stat. 627.408). Under the parol evidence rule, the written contract is presumed to contain the whole agreement, so earlier oral statements cannot be used to contradict it.

Waiver and estoppel

A waiver is the voluntary giving up of a known right -- for example, an insurer that issues a policy knowing an answer on the application is wrong waives its right to deny a claim for that reason. Estoppel stops a party from asserting a right after its conduct led the other party to rely on the opposite. If a producer accepts late premiums for years, the insurer may be estopped from lapsing the policy for one more late payment without notice. Producers should remember that their conduct in the field can create these consequences for the insurer.